By Blair A. Rebane and Eric C. Little

Most franchisees are required to make an ongoing financial contribution to a marketing fund (sometimes referred to as an advertising fund, brand fund or marketing/advertising cooperative), which the franchisor maintains and manages.  Marketing funds add significant value for franchise systems, as the marketing initiatives and promotional programs that are paid for by the marketing fund allow franchisees to benefit from much larger scale and more sophisticated marketing programs than most of them would be able to fund on their own.  From the franchisor’s perspective, taking a centralized approach to marketing and promotions can help to increase brand awareness and drive overall revenue for the franchise system.  While marketing funds offer many benefits, they can also become a source of potential conflict in the franchise relationship.  Franchisees might not have a clear understanding of how their marketing fees are spent, they might disagree with how the marketing fund is used, or they might dislike particular advertising and promotional programs that are paid for by the fund.

This article discusses some of the key items that franchisors should consider in relation to the management and use of their marketing fund in order to reduce the likelihood of disputes.  These include the legal obligations that arise for franchisors in relation to maintaining a marketing fund, ensuring that a franchisor’s form of franchise agreement is reflective of their current uses of the marketing fund, and best practices for meeting franchisors’ disclosure obligations in relation to the marketing fund.

Franchisor’s Obligations

A franchisor’s right to collect, maintain and use a marketing fund arises from the franchise agreement.  Accordingly, a franchisor must ensure that in collecting, administering and using the marketing fund, it complies at all times with the terms of its franchise agreement.  This is particularly important when it comes to how the marketing fund is used, as uses that are not provided for in the franchise agreement may put the franchisor offside of its contractual authority and obligations.[1]  For this reason, it is important that the franchise agreement clearly states in sufficient detail what the marketing fund can be used for.  For example, if the marketing fund is used for the development and maintenance of the franchisor’s website or the operation of a centralized sales centre, then that should be clearly stated in the franchise agreement.

While most franchise agreements specifically disclaim any obligation on the franchisor to ensure that any marketing or promotions conducted using the marketing fund will confer any benefit on any particular franchisee, the franchisor must nonetheless exercise its discretion in respect of the fund in accordance with its duty of good faith and fair dealing.  This requires, among other things, that the franchisor act reasonably, honestly and in good faith in exercising its discretion, and that it does not act without regard to its franchisees’ interests.[2]  Even where the franchise agreement purports to grant “absolute discretion” to the franchisor in relation to administering the fund and determining how it is to be used, the duty of good faith and fair dealing prohibits the franchisor from exercising its discretionary powers unreasonably or in a manner that ignores the interests of its franchisees.

For franchisors and their personnel who deal with the marketing fund, it is essential that they have a very clear understanding of the provisions of the franchise agreement relating to the fund and what those provisions authorize them to do.  Ensuring that the marketing fund is spent in accordance with the terms of the franchise agreement and the duty of good faith and fair dealing will significantly help to reduce the risk of potential disputes with franchisees.

Well-Drafted and Current Franchise Agreement

Since a franchisor’s right to collect, administer and use a marketing fund arises from the franchise agreement, the franchisor must ensure that the terms of the franchise agreement are clear, well drafted and up-to-date.  They must accurately set out the key terms relating to the collection, administration and use of the fund, including:

1. the amount of the contribution that a franchisee must make to the fund (or the mechanism or formula for determining such amount), when and how often contributions are required to be made, and the method of payment;
2. who has the authority to administer and use the fund (e.g. the franchisor, its affiliates or a third party); and
3. the uses that can be made of the fund.

The area where there is the most potential for conflict between franchisees and franchisors is in relation to the uses that can be made of the marketing fund.  Understandably, franchisees want to know what their contributions to the fund are being used for, and they want to see that their contributions are being used effectively and in a way that creates value for the franchise system.  What the marketing fund is used for can vary significantly from one franchise system to another due to many factors such as the nature of the business, the size, maturity and sophistication of the system, and the technology, media and other resources used in the system’s marketing and promotions.  Accordingly, franchisors must ensure that their form of franchise agreement clearly sets out what the marketing fund may be used for, and that it is appropriately tailored to their specific system.

There are two aspects to this.  First, the grant of rights to the franchisor in relation to the marketing fund must be sufficiently broad to give the franchisor the authority and flexibility it needs to manage and use the fund effectively over time.  The advertising needs of franchise systems and the methods available to them are always changing, which makes it very difficult (if not impossible) to capture each and every potential use of the marketing fund with specificity in the franchise agreement.  In this respect, broad language in the grant of rights to the franchisor can assist in capturing potential uses of the marketing fund that might emerge or change in the future.  At the same time, if there are specific purposes that the franchisor knows the marketing fund will be used for, it is important to ensure that the franchise agreement provides for such uses in sufficient detail – particularly if they are not directly or obviously related to marketing.  For example, franchisors should consider whether their marketing fund will be used for any of the following purposes:

1. developing or maintaining a website, online store or e-commerce platform for use in the franchise system;
2. advertising or promotions on the internet or social media;
3. development of software, technology applications or other systems;
4. maintenance and operation of a centralized sales, ordering or customer service system or call centre;
5. conducting customer surveys, market studies, mystery shopper, quality assurance or other programs;
6. public relations and participation in trade shows, conventions, exhibitions and other events;
7. franchise development and recruitment of prospective franchisees; and
8. payment of management fees, staffing costs, administrative expenses, overhead, legal or accounting fees and other expenses relating to the maintenance and administration of the marketing fund and the activities funded by the marketing fund.

Striking the right balance between broad and specific drafting is the key to a well-drafted suite of marketing fund provisions, and the best way to ensure that the franchise agreement will enable the franchisor to manage the fund effectively and in accordance with its contractual obligations over time.

In addition, franchisors should make a point of reviewing the provisions of their franchise agreement relating to the marketing fund on a regular basis to ensure they are up-to-date and accurately reflect their system and their current practices in relation to the fund.  As new forms of technology, media and advertising and promotional methods emerge, and the franchisor’s practices evolve, the language used in the franchise agreement may become outdated and cease to completely or accurately reflect how the marketing fund is being used, and it may no longer be sufficiently broad to capture certain new uses.  While generic language may assist a franchisor with some new or developing uses for the marketing fund, relying on generic language alone may be risky and invite some version of court interference if in fact a dispute arises with a franchisee in relation to how the fund is being used.

Best Practices for Meeting Disclosure Obligations

Pursuant to the franchise regulations in British Columbia, Manitoba, Ontario, New Brunswick and Prince Edward Island, if a franchisee will be required to contribute to an advertising, marketing, promotion or similar fund, the franchisor must provide certain information in relation to the fund in its disclosure document.  The required information varies from province to province, but generally includes the following:

1. a statement describing the fund;
2. the amount or the basis of calculating the amount of the franchisee’s required contribution to the fund;
3. the frequency of the franchisee’s required contribution to the fund;
4. a description of how the fund is administered, including who administers the fund;
5. the percentage of the fund that has been spent on national campaigns and local advertising, and the percentage of the fund that has been retained by the franchisor, its parent or its associates, in the two fiscal years immediately preceding the date of the disclosure document;
6. projections of the percentage of the fund that will be spent on national campaigns and local advertising, and the percentage of the fund that will be retained by the franchisor, its parent or its associates, in the current fiscal year; and
7. whether reports on advertising activities financed by the fund will be made available to the franchisee.

The disclosure requirements relating to the marketing fund are detailed and franchisors must take care to ensure that their form of disclosure document completely and accurately addresses each requirement.[3]  Among other things, the disclosure document should clearly identify who administers the marketing fund (whether it is the franchisor, an affiliate or a third party), and provide a clear and accurate description of how the fund is used.  Generic descriptions of who administers the fund and what it is used for are unlikely to provide the disclosure required by the regulations.  For example, if the marketing fund is used in connection with any of the kinds of activities listed in the preceding section (i.e. activities other than funding national or regional advertising or promotions), the description of the marketing fund provided in the disclosure document should clearly address that.

In addition, it is important to ensure that the disclosure document actually answers each of the required items set out in the regulations.  For example, the fact that a franchisor does not carry out any national advertising campaigns does not mean that it does not have to state what percentage of the marketing fund was used for national campaigns during its previous two fiscal years. [4]  In this scenario, the disclosure document should simply state that 0% of the marketing fund was used for this purpose.

Determining the best approach to discharging a franchisor’s disclosure obligations in relation to its marketing fund is a highly fact-specific exercise and there is no “one size fits all” solution.  That said, one approach that is generally helpful is to provide a summary table or breakdown in the disclosure document which details the various ways in which the marketing fund was used during the two fiscal years immediately preceding the date of the disclosure document and the percentage of the fund that was allocated to each use.  This can help prospective franchisees understand how the marketing fund is used in practice, beyond simply stating the percentages required by the regulations.  It can also assist franchisors in defending any assertion that they did not properly disclose the facts relating to the marketing fund and how it is used.  While some franchisors might be reluctant to provide this level of detail with respect to how the marketing fund is used, the potential for this approach to assist in avoiding claims of deficient disclosure in relation to the fund makes it a worthy consideration.

In addition to the specific information about the marketing fund that must be disclosed pursuant to the various regulations, franchisors must also bear in mind their obligation to disclose all “material facts”.  In the case of the marketing fund, this can include details such as whether a franchisee advisory council or marketing committee has any significant role or input in determining how the marketing fund is used, or if there is anything unusual or specific about the marketing fund or how it is administered and used that could be material to a prospective franchisee.  If there are particular details about the marketing fund that are potentially significant and not already covered by the required information, franchisors should consider carefully whether such details are material and need to be included in the disclosure document.

Key Takeaways

Marketing funds offer many benefits for both franchisors and franchisees, but they can also create some risk of potential conflict in the franchise relationship.  To help reduce the risk of conflict, franchisors are well advised to make sure they know and understand their legal obligations in relation to collecting, administering and using the marketing fund, ensure that their franchise agreement is clear, updated regularly and reflects their current practices in relation to the fund, and ensure that their disclosure document completely and accurately addresses the disclosure requirements applicable to the fund.

About the Authors

Blair A. Rebane is a partner at Borden Ladner Gervais LLP (“BLG”) and the National Leader of the firm’s Franchise and Distribution Group.  Eric C. Little is a partner in the Corporate and Capital Markets Group at BLG, who practices corporate commercial law with an emphasis on franchising, licensing and distribution.

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[1] Shelanu Inc. v. Print Three Franchising Corp., 2003 CarswellOnt 2038, 123 A.C.W.S. (3d) 267 (ONCA) [Shelanu], at para. 95.

[2] Shelanu at para. 96.

[3] 6792341 Canada Inc. v. Dollar It Ltd., 2009 ONCA 385 [Dollar It] at para. 48.

[4] Dollar It at para. 47.